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Saving more for retirement

Posted: 19 August 2010

Author: Phillip Green

Two recent news articles reinforce the need for each one of us to save more for our retirements – they talk about company pensions, but the principles apply to us all.

The first article appeared in the Guardian and explains that several of the largest occupational pension funds in the UK have increased the assumptions they make for the length of time that people will live after retirement. The longer this is the more the pension funds have to pay out, so this means they have had to put more aside to cover their expected costs in the future.

The other article on the BBC points out that a number of FTSE100 companies have had to increase their pension contributions by a massive £17.5 billion more than the usual level of contribution to help make up previous shortfalls. This would have been even more, had stockmarkets not recovered over recent months.

What does this mean in practice?

A shrinking proportion of the workforce is now involved in the best type of pension scheme – those that are based on earnings in the run up to retirement, rather than contributions and investment growth. One reason for this is that employers simply cannot afford the costs involved in sustaining such schemes. Even the government is starting to realise that these so-called ‘final salary’ schemes are no longer affordable for public sector employees.

How does this affect the rest of us?

The important point for everyone who is in a ‘defined contribution’ or ‘money purchase’ pension plan – and that is everyone with personal pensions or stakeholder pensions and most members of smaller occupational schemes – is that they need to hear the same message as the larger pension schemes. If we are living longer – and investment returns may not revert to their previous growth rates for some time to come – we need to consider whether we are putting away sufficient to provide a decent standard of living in retirement.

Unfortunately, the income available from a pension fund has fallen dramatically over the past 20 years, due to a reduction in interest rates, as well as increasing longevity. This means that we need to save much more – perhaps even twice as much, in order to generate the same level of income as previously.

Of course, conventional pensions are not the only way to plan for retirement. Alternatives include Individual Savings Accounts and other, usually less tax-efficient, forms of saving. What is important is that we put aside sufficient to plan to provide an adequate income later in life and that an investment strategy is adopted which is consistent with our tolerance to risk. The nearer we get to retirement, the lower this tolerance is likely to be, because short-term fluctuations that occur close to retirement date can make it difficult to plan adequately.

While interest rates remain low, savers cannot expect realistic returns from deposits. Conversely, equity investments can be risky over the short term. The Bank of England’s Monetary Policy Committee needs to consider the impact on those nearing or past retirement because a rise in inflation with low economic growth could become damaging to their interests.

Retiring at least a year later

It is also worth noting that, if you are currently about 58 to 60, you could find yourself receiving your state pension a year later than anticipated, thanks to a review currently being undertaken by the government as part of its cost cutting exercise.

It is important always to seek independent financial advice before making any decision regarding your finances. The value of investments is not guaranteed; you may get back less than you put in.